Speech by SEC Staff:
Remarks before the 2009 AICPA National Conference on Current SEC and PCAOB Developments

by

Joshua S. Forgione

Associate Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 7, 2009

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect those of the Commission or of the author's colleagues upon the Staff of the Commission.

Introduction

Thank you and good morning. During this session, I'd like to first share some recent thinking on revenue recognition for transactions on a bill and hold basis. Next, I'll discuss joint venture formation transactions and how recent changes by the FASB may result in a re-think of some of the historical views on whether new basis may be appropriate.

Bill and Hold Arrangements

First, let me spend a moment to provide some context to the discussion on bill and hold arrangements. Revenue recognition guidance under U.S. GAAP includes broad concepts as well as a number of areas with transaction or industry specific guidance. If a transaction falls within the scope of specific guidance covering a particular arrangement or industry, then that literature should be applied. As explained in SAB Topic 13 (the "SAB"), in the absence of specific authoritative guidance, it's important to consider the concepts outlined in the FASB's conceptual framework for revenue recognition, which all point to the notion that revenue should not be recognized until it is realized or realizable and earned. The SAB goes on to provide views on how the staff thinks about these concepts and the earnings process in general and provides four criteria which generally should be met prior to recognition.

I'm sure you are eager to hear me dive into each of the four revenue recognition criteria. However, I'll spare you the pain and instead focus on the second criterion that addresses whether delivery and performance have occurred or services have been rendered and share with you some insights on how we have evaluated this criterion in the context of bill and hold arrangements.

Typically, it would not be appropriate to recognize revenue in advance of the seller satisfying performance obligations pursuant to the terms of an arrangement which generally would not occur until delivery of the product to its customer or until services have been rendered. However, in certain situations a customer may purchase goods, but for various reasons the customer may not be ready to take delivery of the product and requests that the seller hold the product for delivery at a later date. In these limited situations, the SAB provides the staff's views as to certain criteria that should be met in order to recognize revenue prior to shipment or delivery. At the time SAB 101 (as amended by SAB 104) was issued, these views were not new and reflected the criteria set forth in various Commission enforcement cases, including Accounting and Auditing Enforcement Release (AAER) No. 108. Practically speaking, these views are an exception to the general revenue recognition criteria related to delivery and performance.

There may be instances where a customer has requested that a product be held on a bill and hold basis but for various reasons the product itself was not complete or in its final form. In this circumstance, I'll highlight two bill and hold criteria in the SAB that would generally preclude revenue recognition if not met:

First, the seller must not have retained any specific performance obligation such that the earnings process is not complete; and

Second, the equipment or product must be complete and ready for shipment.

Let me provide an example to help illustrate these arrangements, particularly when the vendor has retained performance obligations related to the product to be delivered. Assume a vendor has an existing supply arrangement with a customer that requires the customer to purchase a minimum amount of product on a quarterly basis. Current market conditions have led to both a decline in the customer's sales and product orders as well as a corresponding increase in inventory levels and lack of storage capacity. Although the customer's current sales volume supports its continued need to purchase product from the vendor and it has a fixed commitment to do so, the customer requests that all purchases subject to the fixed commitment be held. The vendor holds the goods in an unfinished state because it is less costly to do so and the additional processing is usually done just prior to loading the goods for shipment.

In evaluating the bill and hold criteria in the SAB, the vendor concludes that it meets most of the criteria except that it retains certain performance obligations related to the product such that the product is not in its final form for delivery as specified and requested by the customer. Under these circumstances, we've considered questions on the application of the bill and hold criteria, including possible interaction of those criteria with other revenue guidance on inconsequential or perfunctory performance obligations and multiple-element arrangements.

The concept of inconsequential or perfunctory is based on the premise that the terms of the arrangement are substantially complete in order for delivery or performance to be considered to have occurred. So, assuming all other revenue recognition criteria are met, it would be appropriate for a Company to consider whether post-delivery performance obligations related to a product are inconsequential or perfunctory. However, it would generally be inappropriate to assert that the effort required to complete the product prior to delivery is inconsequential or perfunctory when the product has not been delivered to the customer and additional processing is necessary to complete the product prior to shipment.

With respect to multiple element arrangements, vendors often enter into arrangements where they provide multiple products and services to their customers. As I'm sure many of you are aware, the FASB has recently issued an update to Codification Topic 605 to codify the consensus reached by the EITF concerning how to separate, measure and allocate arrangement consideration to one or more units of accounting. Without getting into too much detail on the codification update, the consensus reached by the EITF will generally require more separation of multiple-element deliverables than previously allowed.

With that in mind, let me provide some further thoughts on the possible interaction of the new guidance on multiple element arrangements with the bill and hold criteria. In the previous example, some may believe that an incomplete product could be considered a separate unit of account from the service required to complete the product prior to shipment. Since the product is not complete or in its final form, a conclusion that identifies an incomplete product in the manufacturing process as a separate deliverable in an attempt to satisfy the bill and hold criteria is questionable. In order to qualify for revenue recognition on a bill and hold basis, the product held must be in the form that the customer will receive upon delivery.

I think it's important to reiterate a comment that I made at the outset of this discussion, that is, arrangements that qualify for bill and hold accounting are an exception to the general revenue recognition principles and should be carefully evaluated.

Joint Venture Formations

I'd like to now discuss some interesting questions that have come up concerning the accounting for joint venture formation transactions. However, before we get into the accounting for the joint venture itself, let's spend a minute discussing some of the recent changes to the investor accounting that seems to be driving some of the interest in this topic.

First, from the joint venture investor's perspective, prior to the adoption of Statement 160, the transfer of a consolidated business in exchange for an interest in a joint venture would not result in gain recognition, absent the receipt of cash or near cash consideration and after careful evaluation of the specific facts and circumstances. After the effective date of Statement 160, which we understand that the FASB has an active project on their agenda to clarify through an Accounting Standards Update, a joint venture investor will recognize a gain or loss upon de-recognition of the consolidated business based on the difference between the fair value of consideration received and the carrying amount of the net assets contributed.

Now, as it relates to the accounting for the joint venture itself, Statement 141(R) excludes from its scope the accounting for the formation of a joint venture. The staff has historically conveyed strong views when considering the use of fair value in recording noncash assets contributed to a joint venture. More specifically, many believe that the staff would only support step-up to fair value when certain conditions are met, including where the asset or business is contributed to a new entity and fair value is supported by an equal amount of monetary assets that either remains in the entity or used by the new entity in transactions with parties other than investors in the venture.

There may be questions developing on the topic of new basis for joint venture formation transactions as a result of these recent changes. The good news or, depending on your perspective, the bad news is that I'm not going to roll out a new model for new basis in joint venture formation transactions. There are certainly a number of good questions surrounding new basis accounting in general. In the absence of additional standard setting, there may be more circumstances where it may be appropriate to record the contributed business at fair value. This is an area that requires a significant amount of analysis and you should carefully evaluate the facts and circumstances surrounding the transaction and determine whether you believe new basis of accounting will result in decision-useful information to investors.

Historical Staff Views

This brings me to my last point that I would like to share with you today. Representatives from our office have spoken at this conference for a number of years to share our experiences in dealing with accounting, auditing and other related matters. However, these speeches have their limitations. I say this because our views are generally developed based on how we think about the application of current GAAP to a particular fact pattern. When GAAP changes the staff's views may also change. Please keep this in mind and feel free to consult with our office if you find yourself in a situation where you believe you have reached a reasonable conclusion but feel constrained by views that may have been conveyed by representatives from our office. The consultation process and protocol is available on our website.